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Cyprus, An Absurd Levy

(Il Sole 24 Ore – A. Quadro Curzio) The bankruptcy of Cyprus and its exit from the euro, with unpredictable consequences for the European Monetary Union (EMU), has been averted, fortunately. The risks were there, even if the Cypriot GDP accounts for only 0.18 percent of the EMU’s, as contagion can also spread from a small infection. This is demonstrated by the statements of relief issued when the bailout agreement was reached by European institutions and by the first evaluations of the international financial media.

The Cyprus crisis and its solution, however, leave open many questions that the European institutions will soon need to clarify in order to avoid the emergence of other risky situations. The questions can be summed up into three: what risks did we run? Does the agreement establish a “paradigm” for any other similar cases? Was the crisis not foreseeable?

As a premise, we must remember that the financial resources needed to save Cyprus are estimated at 15.8 billion euros, of which 10 billion would be supplied by Europe (with a possible contribution from the IMF), while 5.8 billion will need to be provided by Cyprus. A small amount in absolute terms, both in comparison to the figures mobilized for the bailouts of Greece, Portugal, Ireland and Spain, and in relation to the potential of the European bailout fund (ESM) and obviously in relation to the euro zone’s GDP. The amount Cyprus will need to provide is equal to 0.06 percent of the euro zone’s GDP and 1.1 percent of the lending capacity of the EU state bailout fund—a very small amount, although it represents 32.5 percent of the Cypriot GDP.

As for the first question concerning the risks we ran, it’s difficult to give a straight answer. The first hypothesis of an agreement between Cyprus and EU institutions (Eurogroup, European Central Bank [ECB], European Commission) alongside the one that the IMF proposed on March 16 aroused great concern in the international context. A compulsory levy on all bank deposits in Cyprus at a rate of 6.75 percent for up to 100,000 euros and of 9.9 percent for those over that sum, initially appeared to be an anomaly—and not just because of those under the 100,00-euro threshold by warranty.

Those who justified this levy indicated that many deposits in Cyprus were Russian and had obscure origins, while those who opposed it feared the risk of contagion and capital flight in all struggling European countries. The draft agreement was then rejected by the Cypriot Parliament, increasing the risk of Cypriot bankruptcy. Moreover, the Cypriot attempts to obtain Russian aid were fruitless, while the ECB warned that it would discontinue the provision of liquidity to Cyprus if an agreement was not reached within a few days. So Europe has run significant risks.

The answer to the second question (if the result is satisfactory) is also a difficult one. Yesterday’s agreement between the troika (representatives of the ECB, the Commission and the IMF), the Eurogroup and Cyprus’s prime minister can be summed up in three points. The recapitalization of the financial system with the closure of the most struggling bank (Laiki) burdening shareholders, bondholders and clients with deposits exceeding 100,000 euros with the losses. This is a new form of “bail-in”—a novelty for the EMU—which is not as convincing as decisions of this nature should be, adopted in less improvised legal and institutional contexts. Deposits up to 100,000 euros will instead be safeguarded and transferred to the Bank of Cyprus which will keep them alive.

The introduction of stringent anti-money laundering measures: this is another point that deserved (and still deserves) a more in-depth analysis, because if it is true that in Cyprus there is illegal capital, as well as asking why this country was admitted to the euro zone on January 1, 2008, one might also ask why this capital can’t be targeted by specific measures other than those relating to legal deposits of over 100,000 euros.

The adoption of measures to reduce the deficit-to-GDP ratio (estimated at 5.5 percent in 2012 and to expected bring the debt below 100 percent by 2020). Along with these measures, Cyprus needs privatizations and structural reforms to increase competitiveness.

The third and final question has to do with whether or not the crisis was foreseeable. Our opinion is that it was because Cypriot banks were heavily damaged by the restructuring of the Greek debt that they held, because the 2.5 billion-euro Russian emergency loan with a four and a half year maturity supplied in January 2012 clearly pointed to a dangerous situation and, finally, because in March 2012 the rating agencies had begun to classify Cypriot government bonds as junk. The Cyprus request of intervention by the EU state bailout funds in June 2012, after nine months, should not have led to decisions that reek of improvisation, and not only for the Eurogroup’s and the Troika’s night-time meetings.The euro zone and the euro are too important for decisions that might scare depositors and markets. It would be a real shame if the crisis were to have a new downfall now that the situation in Europe is cooling down.